During this
unprecedented month where the flagship S&P 500 has plummeted 23.0%,
it isnít surprising this brutal stock-market selloff is monopolizing
investorsí attention. Thus goldís poor performance is largely
flying under the radars. Month to date, this metal is down a
massive 15.6%! This combined with the
intense stock fears
have led to an unthinkable 46.4% October decline in the HUI
gold-stock index.

Shell-shocked gold
and gold-stock investors are morosely trying to comprehend this
incredible carnage. Traditionally a financial crisis of this
magnitude would have led to a frenzy of gold buying, and we are
indeed seeing this in the physical-gold world where bullion coin
shortages remain acute. But despite the soaring physical demand,
futures traders have sold gold aggressively driving down its price.

Many gold
investors want to blame the usual gold villains, the central banks.
I have no doubt they were selling, but this is nothing new. Since
the Washington Agreement (now called CBGA) was signed in 1999,
European CBs alone agreed to sell up to 400 tonnes of gold annually
until 2004 and up to 500 tonnes a year since. Big CB gold sales are
a constant, always there, and certainly werenít unique to October
2008.

After riding gold
from the $250s to over $1000 between April 2001 and March 2008
despite heavy sustained CB selling over this period, it is very
clear that CBs arenít running the gold market. They are a
persistent headwind, but not a primary driver. Investors and
speculators run this show. Though investment and speculation demand
can fluctuate wildly, it is what has driven this secular gold bull.
Just as gold couldnít have quadrupled without investors and
speculators buying, it canít lose nearly a sixth of its value in
three weeks without them selling.

So why were
traders selling gold so aggressively in the face of the worst
financial panic in decades? Forced selling is certainly a major
factor. If you own gold and get a totally unrelated margin call
from your broker or redemption request from your investors, you
still have to sell whatever you can. And gold remains one of the
most liquid assets in the world. Individuals and hedge funds
getting into margin and leverage trouble were forced to unwind gold
long positions (futures and ETFs) to raise cash fast.

But traders not in
trouble were selling gold too, especially futures. This largely
speculative selling is probably the single biggest reason for goldís
extreme weakness of the past month. I suspect this selling was
largely driven by the extraordinary surge in the US dollar. To most
mainstream traders today, gold is still viewed as the anti-dollar
rather than a unique asset with its own strong
fundamental
merits.

So when the dollar
surges, especially if its move is a big, fast, high-profile one,
gold futures are sold aggressively. I donít think this is rational
anymore in Stage
Two of this gold bull, but this Stage-One thinking is still
pretty popular among futures traders. Regardless of futures
tradersí motivations to sell, logical or not, their sales still add
supply which drives down prices over the near term.

And boy, if you
think goldís whole story is merely that of a dollar-inverse proxy,
there was no better time to sell it than the last few months. The
US dollar, as measured by the venerable US Dollar Index (USDX),
rocketed higher in one of its biggest bear-market rallies in
history. The sheer ferocity of the dollarís run since mid-July
defies belief. The USDX is rendered in blue on these charts with
gold drawn in red.

If you are a
student of the currency markets or a currency trader, you know that
major currencies usually move with all the sound and fury of a
glacier. The currency markets are the worldís largest, they are
hugely important and affect everything else, but they just donít
move very rapidly most of the time. So the massive and fast spike
in the USDX seen here is extraordinarily rare, maybe even totally
unprecedented.

While I suspect it
is unprecedented, I havenít carefully looked at every 3-month
period in the USDXís long history since its early-1970s origin. But
as the next chart will show, this massive USDX surge was easily the
biggest and fastest of this entire dollar secular bear that
stealthily began in the
summer of 2001.
To see this world reserve currency rocket 19.2% higher between July
15th and today is mind-boggling!

Not only does this
massive USDX bear rally look impressive on this chart, a nearly
vertical surge, but it is impressive mathematically too. If you
divide the dollarís huge total-rally gains by this rallyís short
duration, the USDX has been climbing 0.274% per day on average since
mid-July. Such a sustained rate of ascent defies belief, it is
unheard of in the major currencies. Only an extreme crisis could
drive such intense dollar demand.

As late as July
15th, the USDX was grinding along near all-time lows. It
bottomed in mid-April about 7 months after sliding decisively below
80 for the first time in its entire 37-year history. The last chart
in US Dollar Bear
5 shows this entire history if you want some valuable long-term
perspective. By mid-July the dollar was still bottom feeding just
0.5% above its all-time closing low. Global demand for dollars was
weak as foreign investors continued to diversify out of their
dollar-heavy holdings.

During normal
times, the USDX probably would have continued grinding sideways or
maybe rallied modestly to its 200-day moving average (black above)
simply due to being technically oversold. But around this mid-July
time frame as the GSEsí (Fannie and Freddie) stocks plummeted, fears
for the whole global mortgage-backed bond trade really intensified.
Flight capital began to pour into the very highest-quality bonds.

Globally,
short-term US Treasury bonds are considered the safest debt
investment. The US has long had the largest, strongest economy in
the world. And because Washington can use the Fed to create endless
US dollars out of thin air, the US Treasury can never default
(unless Washington is overthrown in rebellion or conquered in an
invasion, neither likely). Sure, bondholders will get paid back in
dollars worth less, but over the short term (a few months) this
inflationary impact to investors is trivial.

Since the US is a
single sovereign nation, as opposed to the often-fragile federation
of competing sovereignties that is the European Union, foreign
investors still have more confidence in US Treasuries than other
government bonds. So as toxic US mortgage debt started to bludgeon
European banks and markets, European bond investors rushed to exit
this hazardous realm. They parked their capital in short-term US
Treasury bills.

This surge in
T-bill demand was so immense it forced T-bill yields to
unprecedented lows. The higher a bondís price is bid up, the lower
its effective yield for a new purchaser becomes since its coupon
payment is fixed on issuance. At one point a month ago, T-bill
prices were driven so high that yields actually briefly went
negative! Investors were effectively paying the US Treasury for
the privilege of lending to it!

The more intense
the financial panic grew, the greater the deluge of flight capital
desperately seeking the safety of short-term US Treasuries. For
American investors, this was easy. But foreign investors selling
their local bonds for local currencies couldnít buy T-bills
directly. After selling their bonds, they first had to convert the
proceeds into US dollars to enter the Treasury market. This drove
the unbelievable US dollar demand responsible for its huge spike.

The US Dollar
Index is tradersí favorite proxy for the US dollarís relative price
among major world currencies. And it is dominated by Europe. The
euro alone accounts for 57.6% of this indexís total weight, and the
UK, Sweden, and Switzerland add another 19.7% on top of this. So a
whopping 77.3% of the dollarís behavior, as reckoned by the USDX, is
driven by Europe.

European financial
stocks, and hence stock markets, were hit hard in recent months by
the growing problems with mortgage-backed debt. Many analysts
believe that European banksí exposure to bad mortgage debt (both US
and European) is much worse systemically than US banksí exposure,
which is rather ironic since the sub-prime mess originated in the
States. So European investors aggressively liquidated European
bonds and stocks and sought a temporary safe haven to weather this
storm.

That safe haven
was US Treasury bills. Before buying them, most European investors
converted their local currencies into US dollars. Thus this
financial panic drove incredible levels of euro selling, so the
euro-heavy USDX soared. This giant flight-capital trade out of
euros (and pounds, kronor, and francs) led to incredibly intense
dollar demand. And the result of this unprecedented event is
evident in this chart.

On July 15th just
before this dollar rally ignited, gold was trading at $976 an ounce,
not far from its bull high of $1005 from mid-March. And gold in
euros was running near Ä614. While disappointing to contrarians
expecting some flight capital to seek goldís unparalleled safety,
perhaps we shouldnít be surprised that such a violently fast 19.2%
USDX rally would drive futures traders to sell gold aggressively.

Over this same
span of time, gold was down 25.4% in US dollar terms. Such a fast
gold decline, coupled with indiscriminate panic selling across
all stock-market
sectors, drove the horrific losses in gold stocks. Like many
prices weíve seen in recent weeks, I certainly believe gold and gold
stocks were driven to absolutely unsustainable levels and will
quickly surge once rationality starts returning to the markets.

While this gold
plunge feels terrible, American gold investors need to understand
that our perception of what happened in gold in recent months was
really distorted by the panic flight into dollars to buy US
Treasuries. Over this same span of time where USD gold fell 25.4%,
euro gold only fell 7.8%. In fact, in early October euro gold
carved new all-time highs near Ä673 that were actually 3.9% above
its previous March highs!

So independent of
the crazy dollar surge, gold actually did pretty well around the
world. Some of the flight capital out of international stocks and
bonds indeed fled into gold, as expected. And if gold was easier to
trade, I suspect many times more capital than entered gold would
have joined in. Even you or me, in a similar dire situation as
these big money managers, would probably also have chosen US
Treasuries over gold in the heat of the moment. Hereís why.

Imagine you are
running billions of dollars of Other Peopleís Money in your fund,
and you are taking a big hit like everyone else on the planet. You
love gold personally, but you have to get your clientsí capital out
of harmís way fast. You can sell your stocks and bonds and
get cash as fast as you want, so liquidating is easy. But how do
you put billions of dollars into gold fast?

Physical gold
would be best, but it would take weeks to arrange such a big buy,
not even considering taking delivery and securing your gold
bullion. And the coin market is far too small for big funds to
enter without a radical price impact. And if you arenít a futures
trading house, you canít buy futures since you have no
infrastructure in place to do it. And even if you think ETFs are
fine in normal times, they are ultimately just paper gold so you are
probably wondering what will happen to gold ETFs if their issuing
entities succumb to the growing financial panic.

So sadly, even if
you want to buy gold in a financial panic, it isnít easy for a big
fund manager. But in the time it takes for you to read this
sentence, you could deploy billions into US Treasuries. They sure
arenít gold, but they arenít going to lose value like everything
else and there is a near-zero chance that Washington will fall
before these 3-month instruments are redeemed. So despite loving
gold myself, I donít fault big fund managers for choosing the ease
of T-bills over gold during such a time-sensitive panic.

Now realize I am
not arguing that Treasury debt is better than gold, far from it.
Gold has preserved wealth for millennia before Washington and will
keep preserving wealth long after Washington fades. But I can still
understand why fund managers canít easily move billions into gold as
fast as they can into effectively safe short-term
Treasuries. I donít like it either, but the flight out of the world
stock and bond markets and into US dollars and T-bills in the face
of unprecedented
levels of fear and uncertainty is definitely logical.

The resulting
hyper-fast and massive rally in the USDX was amazing, and I wanted
to understand it within the context of the US dollarís secular
bear. This next chart shows all the major bear rallies witnessed in
the USDX since its bear began in July 2001. Our current is actually
the 10th, and technically it started in mid-April 2008 at the USDX
all-time low although the dollar was still effectively flat until
mid-July.

For each USDX bear
rally, the top blue number describing it is its absolute percentage
gain. The next white number is its duration in months. The second
blue number below that is its average gain per day, a measure of
velocity and intensity. Finally the red number is what happened to
the US dollar price of gold over an identical span of time. As you
can see, todayís dollar rally has been unbelievably big and fast.

At 19.9% in 6.3
months, nothing else even comes close to our current massive USDX
bear rally. The next biggest dollar bear rally is the 6th above,
ending in November 2005. Yet it was only 14.6% absolute and it
occurred over a much longer 10.6 months. This translates into a
velocity of just 0.066% per day compared to our current specimenís
crazy 0.151% per day. And if you reckon our current rally starting
0.5% higher at July 15th instead, its velocity was an amazing 0.274%
per day. This is mind-blowing for a major currency!

There are a few
other dollar bear rallies with higher velocities above, but they
were all extremely short-lived and only lasted a matter of weeks.
To see the USDX power higher so aggressively for a matter of
months is absolutely unprecedented in this bear. And
considering how extreme this USDX rally was, gold really did do a
decent job of holding its own. The gold carnage certainly could
have been worse.

Over this 10th
rallyís total span since mid-April, gold fell 23.0% while the USDX
rallied 19.9%. As a ratio this 1.16x inverse relationship isnít bad
compared to bear precedent. For example in the dollarís 3rd major
bear rally the gold price fell 8.1% on a 4.3% dollar rally, a 1.88x
inverse. During the 7th dollar bear rally in mid-2006, gold plunged
19.4% while the USDX only rallied 3.8%. Of course that particular
episode, like today, was after a very sharp gold upleg so gold had
technical reasons of its own to correct.

Goldís absolute
levels compared to the dollarís in this rallyís aftermath are also
interesting. The USDX rocketed up to November 2006 levels, gaining
back two yearsí worth of losses. Meanwhile gold only retreated to
September 2007 levels, temporarily erasing one yearís worth of
gains. This might not be much consolation when considering the
impact of todayís irrational gold price on your portfolio, but gold
really did weather this extreme dollar rally fairly well.

Since panic drove
this sharp dollar surge, what happens when this panic abates? I bet
the dollar collapses almost as fast as it rose. Of course gold
would probably soar in such a scenario. This case can be made in
both sentiment and fundamental terms, and both are very compelling.
Market anomalies driven by extreme emotions typically unwind once
the driving emotions finally peter out.

All over the
world, money managers are hunkered down in short-term Treasuries.
Yet T-bill yields are now running around 1%. This is pathetic. How
many money managers are going to be comfortable reporting to their
clients that they are only earning 1% before fees? So the moment
the markets turn in the
inevitable
V-bounce, money managers are going to want out of Treasuries and
back into assets that are either rallying or actually yielding
something.

These money
managers will sell Treasuries, sell dollars (if they are foreign),
buy their local currencies, and start aggressively redeploying
capital. 2008 has been a bad year in the markets for everyone, yet
professionals still fear nothing more than underperforming their
peers. So if they perceive rallies anywhere in stocks or bonds,
they are going to dump Treasuries fast and rush to participate to
mitigate some of their 2008 losses before year-end results are
reported to their clients.

There are also
fundamental reasons to unwind this anomalous dollar-long surge.
Over the long term, relative yields drive currencies. While target
rates are running 1.5% in the States, over in Europe the ECBís
benchmark rate is still 3.75%. Why would European bond investors
want to hang out one day longer than necessary in terribly-yielding
US Treasuries when they could buy high-quality bonds in their own
countries yielding 2x to 3x as much? European yields are very
favorable for euro currency buying.

In addition,
real rates of
return (inflation-adjusted bond returns) are now massively
negative in the US. The low-balled CPI has surged by an
absolute 4.9% in the past year yet 1-year Treasuries are now only
yielding 1.7%. Thus investors in short-term Treasuries are
effectively guaranteed a 3.2% loss in real purchasing power annually
by owning them thanks to the Fed. So while short-term Treasuries
are attractive in a panic, the moment fear fades they return to
being terrible investments.

For these reasons
among many, I maintain the contrarian stance that this sharp dollar
surge will rapidly unwind as soon as the intense systemic fear
passes and money managers get comfortable enough to return to their
usual stock and bond markets. The USDX spike is not the beginning
of a new bull, as new bulls are driven by positive fundamentals that
definitely donít exist for the dollar. Instead this was just an
emotional anomaly that drove a spectacular bear rally that simply
isnít sustainable.

And when this
dollar panic buying reverses itself, so will the gold panic
selling. The metal is just way too cheap today relative to its
bullish fundamentals and the incessant fiat-currency growth all over
the world. This anomaly is a heck of an opportunity for new
long-side capital to deploy into gold and gold stocks. Virtually
everything gold-related is available at such a discount today that
it may be the best buying-op of this bull.

I am going to
discuss all this, including specific trading strategies and trades,
in our upcoming
Zeal Intelligence monthly newsletter. October 2008 was very
frightening and painful, but it has led to some of the most amazing
prices we will ever see in awesome investments and speculations.
Buying into this fear is tough, but fortunes will be made when the
recovery arrives.
Join us today and donít squander this once-in-a-generation
opportunity!

The bottom line is
extreme circumstances, a rare global financial panic, drove the
sharp rally in the US dollar. And this massive and fast dollar
rally hammered gold. But once the panic abates and money managers
all over the world start chasing good returns again, the dollar-long
T-bill buying frenzy will reverse hard. And as the USDX sinks again
to reflect its dismal fundamentals, gold will really shine.